Derivatives trading costs could double in times of market stress

Initial margin could surge by up to 94% for some derivatives portfolios during periods of high volatility, research from OpenGamma finds.

Initial margin requirements in times of market volatility could see the costs of trading derivatives almost double for some firms, according to OpenGamma.

The analytics specialist investigated the impact of calculated stress on margin for a number of client portfolios using historical data for margin rates for listed futures contracts between 2008 and 2018. The research found that initial margin for one client portfolio, consisting of fixed income futures contracts traded on SPAN exchange CME, could surge by up to 94% at times of high volatility.

As global trade tensions continue alongside rising US interest rates and growing debt, OpenGamma said fund managers will be navigating unpredictable market movements in the months ahead, adding particular pressure to firms trading eurobond futures. Further analysis showed that one client portfolio consisting of bond futures traded on VaR-based exchange Eurex could see margin requirements surge by up to 70% at time of market stress.

Peter Rippon, OpenGamma’s chief executive, commented that hedging is an effective tool to combat the unexpected higher costs during market volatility. The research continued that after hedging, the CME futures portfolio saw margin increase at 14% rather than 94%, while the Eurex Eurobonds portfolio saw margin increase at 35%, rather than 70%.

“By using an efficient hedging overlay, firms can soften the spike if the right strategy is implemented,” Rippon said. “No fund manager wants to be posting more margin than they need to. Understanding how to control initial margin costs will be key for firms to maintain liquidity, as they may need sufficient cash to buffer against unpredictable market conditions.”

BNY Mellon revealed earlier this year that clients are already preparing for the new wave of initial margin requirements due to come into force in September. Under the European Market Infrastructure Regulation (EMIR), authorities have been phasing in initial margining requirements for firms trading bilateral OTC derivatives.

“With Brexit looming and Trump’s ongoing trade war with China, the next few months present a daunting prospect for fund managers trying to combat the inevitable volatility. This is why, during these periods of market turbulence, understanding which positions are likely to incur a larger increase in margin requirements is imperative in order to reduce costs,” Rippon concluded.